The New Housing Bubble Just Began

Think you know why stocks and housing are booming? No, it’s not low interest rates and strong employment. It’s because the top three American banks by assets all just introduced new products aimed at providing riskier mortgages. It’s housing bubble 2.0.

You’re going to be angry after reading this Letter.

Today, I am going to reveal what no other media outlet has, so please read this Letter in its entirety.

A couple of weeks ago, I explained why I believed the stock market rally could end this year and why I believed gold could climb higher.

But last week, the rally didn’t end and gold didn’t climb.

Instead, the stock market moved higher, while gold was smashed back down to the low $1200’s.

So was I wrong?

I don’t think so. In fact, I believe we’re being set up.

Let me tell you why.

Stock Outflows Continue

Two weeks ago, I told you that “stock funds in the United States posted outflows in 15 of 19 weeks and investors are pulling money from global equity funds at their fastest pace since 2011.”

Today, they’re still pulling out.

According to Financial Times:

“…Equity funds suffered their seventh consecutive week of outflows, shedding another $9.2bn for the week ending May 25, taking their total outflows for the year above $100bn, according to data from EPFR.”

It isn’t just the “smart money” selling, retail investors are too.

Via Bank of America:

“Equities continued to experience outflows and lost $3.32bn (-0.1%) last week, their 4th consecutive decline. Year-to-date, equity funds have lost $58.6bn (-0.6%), the largest ever dollar outflow in any 22 week period for the asset class.”

And as I mentioned before in “The Fed’s True Plan,” this shift from stocks is going exactly where it was planned to go: debt.

Via FT:

“Money market funds that invest in government assets also saw big inflows, receiving almost $18bn of new money, according to data from the Investment Company Institute.”

So if investors and the “smart money” are exiting stocks and buying debt instead, how are stocks climbing higher? More importantly, who is buying?

The Corporate Buybacks

When it comes to companies returning capital to their shareholders, the two general methods have been via stock buybacks and dividends.

Dividends show investors that income is healthy, while stock buybacks shrink the total shares outstanding, making the glorified earnings per share look better.

Via How the Fed Influences the Stock Market:

“…When a company issues a share buyback, the amount of outstanding shares in a company decreases. This leads to a higher Earnings Per Share (EPS), which makes the stock look much more attractive. This, of course, leads to higher share prices.”

I have already told you that over the past years, corporate share buybacks have been tremendous.

In fact, over the last five years, the biggest buyer of stocks – by a wide margin – have been corporations themselves, buying trillions of dollars of their own stock.

According to Fact Set:

“The dollar amount spent on share buybacks for the trailing twelve months ending in Q4 (2015) totaled US$568.9 billion.”

If you combine dividends and stock buybacks, corporations paid out nearly $1 trillion last year.

And according to Moody’s, US non-financial companies held a whopping $1.68 trillion in cash at the end of 2015.

That means much of the profits over the last years haven’t gone to investing in infrastructure, growth, or hiring new employees. In fact, much of these profits haven’t even been taxed – meaning they’re not entering the economy.

Via WSJ:

“There’s a funny thing about the estimated $1.7 trillion that American companies say they have indefinitely invested overseas: A lot of it is actually sitting right here at home.

Some companies, including Internet giant Google Inc., software maker Microsoft Corp. and data-storage specialist EMC Corp., keep more than three-quarters of the cash owned by their foreign subsidiaries at U.S. banks, held in U.S. dollars or parked in U.S. government and corporate securities, according to people familiar with the companies’ cash positions.

In the eyes of the law, the Internal Revenue Service and company executives, however, this money is overseas. As long as it doesn’t flow back to the U.S. parent company, the U.S. doesn’t tax it. And as long as it sits in U.S. bank accounts or in U.S. Treasurys, it is safer than if it were plowed into potentially risky foreign investments.

In accounting terms, the location of the funds may be just a technicality. But for people on both sides of the contentious debate over corporate-tax reform, the situation highlights what they see as the absurdity of rules that encourage companies to engage in semantic games, legal gymnastics and inefficient corporate-financing methods to shield profits from U.S. taxes.”

With this much cash, there’s still plenty of room for more stock buybacks in the coming years.

But while everyone is piling in on the share buyback euphoria, keep this in mind:

Buybacks hit a record $762 billion in 2007.

The next year, the market crashed.

Had it not been for the continued decline in earnings, share buybacks could have been much higher last year.

Via WSJ:

“…planned future buybacks are the highest for any year’s first 10 months, more even than in 2007.

“If companies execute their plans, we are looking at a record amount being deployed over the next couple of years,” said Birinyi analyst Robert Leiphart.”

There are little signs that earnings will improve much this year. Perhaps the best evidence of that is the slowdown in corporate buybacks.

Via Bloomberg:

“After snapping up trillions of dollars of their own stock in a five-year shopping binge that dwarfed every other buyer, U.S. companies from Apple Inc. to IBM Corp. just put on the brakes.

Announced repurchases dropped 38 percent to $244 billion in the last four months, the biggest decline since 2009, data compiled by Birinyi Associates and Bloomberg show.”

So if the largest buyer of stocks over the last five years is slowing down their purchases, and both retail and smart money investors are pulling out, who will come to save the day?

More importantly, who is buying stock and how is the market higher?

I can tell you that the market was manipulated higher, but just saying that would be conjecture.

But here’s what I can tell you: the primary reason for the market’s ascension last week was the result of a supposedly new housing boom taking place.

Housing Bubble 2.0

New homes in the U.S. surged in April to the highest level since the start of 2008 – it was the biggest jump in sales in nearly a quarter century.

US Home Sales Surge

Via Bloomberg:

“Purchases of new homes in the U.S. surged in April to the highest level since the start of 2008, pointing to a robust spring selling season for builders, Commerce Department figures showed Tuesday.

Key Points

  • Rose 16.6 percent to 619,000 annualized rate (forecast was 523,000)
  • Monthly increase was biggest since 1992, while pace was strongest since January 2008
  • Median selling price jumped 9.7 percent to a record $321,100
  • Number of homes sold but not yet under construction climbed to 209,000, the highest since May 2007.”

This report was more than enough to give the S&P 500 its biggest weekly gain in 2 months.

But where the heck did this surge in home sales come from?

Well, according to the Bloomberg article, it’s because things are getting better:

“The rebound in purchases of new properties, combined with stronger demand for previously owned homes, signals housing is being energized by healthy employment gains and cheap borrowing costs.”

But wait a second, we know that employment and wage growth isn’t really getting better.

This is evidenced by the mass layoffs across all sectors.

Via Challenger Gray:

“The pace of downsizing increased in April, as US-based employers announced workforce reductions totaling 65,141 during the month, according to the latest report released Thursday from global outplacement consultancy Challenger, Gray & Christmas, Inc.

The April figure represents a 35 percent increase over March, when employers announced 48,207 planned layoffs. Last month’s job cuts were 5.8 percent higher than the 61,582 recorded in April 2015.

Employers have announced a total of 250,061 planned job cuts through the first four months of 2016. That is up 24 percent from the 201,796 job cuts tracked during the same period a year ago.

It is the highest January-April total since 2009, when the opening four months of the year saw 695,100 job cuts.”

And when it comes to wage growth, that too may be distorted.

Via Bloomberg:

“The true strength of the American labor market may be disguised.

… Policy makers have identified wages as one of the most disappointing features in a labor-market recovery that has seen the biggest back-to-back annual payroll gains in 16 years, the jobless rate cut in half and a recent surge in the labor force. The data are being distorted by the retirement of highly paid baby boomers just as lower-wage workers re-enter the workforce after being sidelined during the last recession, according to Fed analysts.

… In a recent research paper with Bart Hobijn, an economics professor at Arizona State University, and Benjamin Pyle, a research associate at the San Francisco Fed, she argued that the disproportionate firing of low-wage workers during the 2008-2009 recession propped up aggregate wage measures at the time. Bringing those workers back into the labor force is now a drag on pay growth. It’s amplified by the retirement of those born during the baby boom between 1946 and 1964, who make up more than 20 percent of the American population.”

If interest rates are already low and expected to rise, how is it possible that home sales are so strong? What exactly is fueling this boom?

Let me tell you. You won’t be pleased…


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Pile on the Risk: Bear Stearns 2.0

Last month, Wells Fargo, the largest U.S. mortgage lender and third-largest U.S. bank by assets, finally admitted to “deceiving the U.S. government into insuring thousands of risky mortgages, as it reached a record $1.2 billion settlement of a U.S. Department of Justice lawsuit.”

Via Reuters:

“…According to the settlement, Wells Fargo “admits, acknowledges, and accepts responsibility” for having from 2001 to 2008 falsely certified that many of its home loans qualified for Federal Housing Administration insurance.

The San Francisco-based lender also admitted to having from 2002 to 2010 failed to file timely reports on several thousand loans that had material defects or were badly underwritten…”

With a $1.2 billion loss now on its balance sheet, Wells Fargo will have to make that back somehow.

That somehow turns out to be, well, more risky loans.

Via LA Times:

“Wells Fargo & Co. has started offering a new type of mortgage that requires a tiny down payment and could appeal to customers who might otherwise get loans backed by the Federal Housing Administration.

…Most big banks have pulled back from offering FHA loans after dealing with lawsuits and billion-dollar settlements connected with underwriting problems. Wells Fargo had been the exception, but with its new loan program, called Your First Mortgage, the San Francisco bank could soon be making fewer FHA loans.

… Your First Mortgage requires a down payment of just 3% of a home’s purchase price, smaller than the minimum 3.5% down required for FHA loans.”

They’re not the only ones offering these non-FHA, 3%-down, riskier mortgages.

Last week, JP Morgan announced the launch of a similar product.

Via HousingWire:

“…According to Chrisman and Chase, the megabank (JP Morgan) recently rolled out a loan program it calls the “Standard Agency 97%” program, which offers customers the opportunity to put down 3%.

The loan is designed for first-time homebuyers who have limited cash for a down payment and closing costs. A representative from Chase confirmed to HousingWire that this new program is done with Fannie Mae backing.

…For loans with a loan-to-value ratio greater than 95% to 97%, the remainder of the down payment and closing costs can come in the form of a gift, Chase confirmed.

Additionally, consumers who take part in the program can actually put 0% down on any loan with a LTV lower than 95%.”

You know what that means?

It means that a customer can now put 0% down on a house, as long as the house is appraised at more than what the house is selling for!

The Bank of America also announced a similar program back in February.

Via HousingWire:

” … Bank of America unveiled a new affordable mortgage program that offers consumers the option of putting as little as 3% down and requires no mortgage insurance. The program does not involve the Federal Housing Administration, whose program has recently undergone a lot of scrutiny from big banks.

Bank of America announced a partnership on Monday with Self-Help Ventures Fund and Freddie Mac for its new “Affordable Loan Solution” mortgage, a conforming loan that provides low- and moderate-income homebuyers access to a responsible lending product with counseling at affordable entry prices.”

So who takes on the risk if these loans go south?

Via WSJ:

“The Self-Help Ventures Fund, a Durham, N.C.-based nonprofit, agreed to absorb some losses in the event a borrower defaults, to reduce the cost of that product.”

Self-Help, which comprises a state and a federally chartered credit union as well as the ventures loan fund, has a tiny $1.6 billion in assets.

That means it could easily be overwhelmed by defaults – especially considering the value of potential mortgages being made under these programs.

“Self-Help said the Bank of America product is on pace to make between $300 million and $500 million in mortgages within the first year.”

That’s just the Bank of America. Self-help is also backing Wells Fargo’s program.

“Self-Help…also teamed up with Wells Fargo to take on the risk of a borrower defaulting on some mortgages in its program.”

In other words, a small credit union with a small fund could likely be backing more mortgages than it has in total assets by the end of this year.

But don’t worry.

If it all comes crashing down, the government-sponsored taxpayer-sponsored Fannie Mae and Freddie Mac may once again be there to bail them out.

Here’s the punch line:

The top three US banks by assets are now ALL participating in riskier mortgages.

So is job growth really the cause of this housing boom report in April, or are the newly created 3%-down housing loans the real culprit?

You tell me.

At Great Risk

I am not saying that the world and US stocks are going to come crashing down tomorrow, but the risk in the broader market is much greater now than anytime post-2008.

That doesn’t mean you should get out of all stocks, but given the risk associated with the broader market, I would much rather risk my money in smaller individual stocks thathave the potential to yield a much greater return than the broader market ever could.

At this point, I believe the risk to be the same in both.

Gold’s Decline

Despite gold’s recent decline – one that has been pricing in the potential of a US rate hike – I still believe gold will climb higher.

In fact, after the dust settles from the Fed meeting between June 14 -15, I believe it will provide a great entry point into many gold stocks.

We are now witnessing the fastest pace for a U.S. debt selloff by global central banks since at least 1978.


Via CNN:

“China, Russia, and Brazil sold off U.S. Treasury bonds as they tried to soften the blow of the global economic slowdown. They each sold off at least $1 billion in U.S. Treasury bonds in March.

In all, central banks sold a net $17 billion. Sales had hit a record $57 billion in January.

So far this year, the global bank debt dump has reached $123 billion.

It’s the fastest pace for a U.S. debt selloff by global central banks since at least 1978, according to Treasury Department data published Monday afternoon.”

Meanwhile, we are witnessing the continued accumulation of gold by these nations.

It’s clear that the demand for gold is rising.

According to World Gold Council:

“Gold demand reached 1,290 tonnes Q1 2016, a 21% increase year-on-year, making it the second largest quarter on record. This increase was driven by huge inflows into exchange-traded funds (ETFs) – 364t – fuelled by concerns around the shifting global economic and financial landscape.”

In other words, nations are dumping US Treasury and buying gold.

According to the World Gold Council, Russia increased its gold reserves by 45.8 tons in the first quarter of this year – 52% higher than the same period in 2015. China piled on another 35.1 tons between January-March, adding to the 103.9 tons it bought through the second half of last year.

China and Russia account for nearly 85% of gold purchases by central banks over the past two years.

This trend doesn’t appear to be slowing.

Just over a week ago, China’s biggest bank, ICBC Standard Bank, announced that it will be buying a massive 2,000-Ton London Gold Vault From Barclays.

Via Bloomberg:

“The vault, which can store 2,000 tons of gold and other precious metals such as silver, platinum, palladium, was opened by Barclays in 2012 and took more than a year to build. The location of the vault is secret, but the lender has said it’s within the M25 road that orbits London. Its decision to exit the business comes as U.S. and European Union regulators investigate whether at least 10 banks — including Barclays, JPMorgan Chase & Co., and Deutsche Bank AG — manipulated prices of precious metals such as silver and gold.”

China’s appetite for gold is only getting bigger.

Recall in a previous Letter that ICBC will be the third Chinese direct participant to join the LBMA Gold Price. That means Chinese banks will represent a quarter of the banks responsible for setting the price of gold.

At the same time, China just launched a yuan-denominated gold benchmark to exert more control over the pricing of the metal and boost its influence in the global bullion market.

It’s no wonder inflows into gold-backed ETFs in China have risen “exponentially” in recent months.

According to the World Gold Council:

“Inflows into gold-backed ETFs in China have risen exponentially in recent months. Although they still only account for a very small proportion of the 1,974t held in these products globally, Chinese gold-backed ETFs on aggregate attracted 11.1t of inflows during the first quarter, more than doubling their holdings in the process.”

One could make the argument – and we have before – that the Chinese could be suppressing the price of gold to accumulate more.

But the end result is the same: gold is being used as currency protection in a world where currency risk is extremely high.

Furthermore, this risk-off sentiment by investors is gaining steam.

We just saw a net withdrawal of US$2.1 billion in high-yield (riskier) bonds, the heaviest in 15 weeks, as more than 70 corporate borrowers have defaulted globally so far this year – the fastest pace since 2009.

We’re now at a point where the markets are frothy and the smart money is moving away from riskier assets. Meanwhile, we’re witnessing the onset of a housing boom via riskier mortgages.

The last time this happened, 2008 struck.

When will we learn?

Comments 4
  1. Hi,
    I like your newsletters very much. I appreciate the insight and the amount of the analysis that I myself can’t achieve. Thank you. Really helpful to look at a bigger picture. I receive a lot of other newsletters from other sources just to be able to look at the process from different angles and I have to admit I take yours most seriously . Stock picks that you offer are not frequent but proved to be good ones. I used NMI as a testing example and didn’t get in on time. Now it’s a little bit expensive. Used your tip on ICG though. Thanks again. The reason I’m responding is that I went through the collapse in 2008- 2009 . The whole market went down and resource sector ,too. Gold miners plunged as well. You are saying that the stock market is about to dive soon. In the same time you’re promoting gold stocks (some of them, at least) and the gold in general. I tend to agree, The thing is that the experience of 2008-2009 tells me if the whole market will go into correction , so will do the gold and gold miners. Which means if you are right about the coming “doomsday” in Dow Jones it will affect gold miners ,too. Which means get some cash and wait for the moment.


  3. After spending MUCH money, and MUCH time, subscribing to, and paying for, the “advice” & “guidance” of “experts” in the “Financial Newsletter Industry”, I can say only this….

    SHOW US YOUR PORTFOLIO PERFORMANCE for the last 5 years, 10 years, 20 years.

    ACTUAL performance speaks MUCH louder then words.

    And as we all know, TIMING one’s entry and exit from any asset class is paramount.

    Or to make it about as clear to you and your kind as possible, MONEY TALKS, BULLSHIT WALKS.

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